Introduction
The COVID-19 global pandemic and the various national lockdowns that have been imposed in South Africa as a result will undoubtedly cast a long shadow over this country’s economy. Predictions of economic hardship as a result of recession, reduced productivity and increased unemployment can still be found in almost every major news publication. In this context, the law of insolvency will be front and centre as businesses find themselves in worsening financial situations and creditors clamour for payment.
While there is a lot of uncertainty about how the coming years will play out for local businesses, an understanding of the law of insolvency can provide a lot of clarity on the available options for companies that find themselves in a difficult financial position. This article serves as a brief introduction to the concepts of liquidation and business rescue, what they are designed to do and how they function.
Insolvency
It is worth considering, in the context of an examination of the law of insolvency, the differences between factual and commercial insolvency, as the distinction will have an impact on how the company’s affairs are handled when it comes to liquidation and other aspects of insolvency law.
South African law has long recognised a difference between commercial and factual insolvency, and the courts have confirmed the continued applicability of this distinction to the Companies Act 71 of 2008 (“the new Act”) in recent cases such as Boschpoort v Absa¹ and Murray v African Global Holdings². Essentially, factual insolvency is a situation where a company’s liabilities exceed its assets and commercial insolvency is a situation in which a company is “in such a state of illiquidity that it is unable to pay its debts, even though its assets may exceed its liabilities”, as and when they fall due.3
Put differently, the question of whether a company is commercially insolvent “requires an examination of the financial position of the company at present and in the immediate future to determine whether it will be able in the ordinary course to pay its debts, existing as well as contingent and prospective, and continue trading”.4
Liquidation
Liquidation is a statutory process for a company to be wound up in the hands of the Master of the High Court. Liquidators (or joint liquidators) are appointed by the Master to investigate the company’s financial position, collect debts owing to the company, sell its assets and to pay its creditors in the prescribed order and process set out in the Insolvency Act 24 of 1936. Once the process is complete and the company wound up, the Master will advise the Companies and Intellectual Property Commission (“CIPC”), which handles the registration of all companies in South Africa, to record the dissolution of the company and remove its name from the companies register.
The liquidation of insolvent companies is still regulated by Chapter XIV of the Companies Act 61 of 1973 (“the old Act”). A company can be wound up voluntarily, by resolution of the company, either as a members’ voluntary winding-up or a creditors’ voluntary winding-up, or by order of a court. A company may be liquidated by a court in a number of circumstances, such as when a company is deemed unable to pay its debts because it has failed to respond to a statutory demand in terms of section 345 of the old Act, the company has resolved by special resolution to be wound up by the court, or where the court finds it just and equitable to wind up the company. A close corporation is also liquidated in terms of the rules in the old Act, as set out in section 66 of the Close Corporations Act 69 of 1984. It is worth noting here that continuing to trade when a company is insolvent may result in personal liability for directors in terms of section 424 of the old Act, which provides for a person who knew that a business was being carried on recklessly or with the intent to defraud creditors to be held personally liable, without any limitation of liability, for the Company’s debts.
While the process differs slightly between the divisions of the high court, copies of a liquidation application must be served on the company’s employees, the trade unions that the employees belong to (if any), the office of the local Master of the High Court, the South African Revenue Service and to the company itself at its registered and trading addresses so that all affected parties are aware of the application and have an opportunity to oppose it. Once a liquidation order has been granted by a court, it is usually advertised in local newspapers and the Government Gazette, as well as being served on the interested parties listed above. The Master of the High Court will then appoint a liquidator, or several co-liquidators, to wind up the affairs of the company. The Master will, by publication in local newspapers and the Government Gazette, call a meeting of creditors so that they can formally lodge their claim against the company’s estate. The liquidator can also call further meetings for this purpose. At this stage there can also be investigations, if necessary, into how the company’s business was conducted and whether the directors or other responsible persons may have been responsible for the company’s decline. These can be initiated by the liquidator or by other creditors who have proven a claim in the company’s estate.
Under the Master’s supervision, the liquidator takes over the practical, day-to-day and administrative running of the company. He (or she) can oversee the continued running of certain parts of the business during the liquidation, sell the company’s movable and immovable property, reach agreements with creditors, collect debts owed to the company, bring legal proceedings in the company’s name and otherwise act to protect and administer the affairs and property of the company. Ultimately, the liquidator will draw up a liquidation and distribution account, which will set out clearly to the Master what funds the company has been able to recover, through the recovery of debts owed to it or the sale of assets, and how much the creditors will be paid.
While it is true that generally only companies in financial difficulty are liquidated, it is also possible to liquidate a company that is not insolvent, that is commercially solvent
(see Boschpoort v Absa5), in terms of Part G of Chapter 2 of the new Act, either voluntarily by the company through a resolution or through a court order. It is possible to approach the court for an order winding up a solvent company in terms of section 81 of the new Act in a number of circumstances, such as when Business Rescue fails, where the directors are deadlocked and the company is suffering, or likely to suffer, irreparable harm or cannot continue business, or where it is just and equitable to wind up the company. A shareholder can also apply for an order to wind up the company if the directors have acted fraudulently or illegally or the company’s assets are being misused or wasted.
Liquidation is an important and necessary tool to ‘wipe the slate clean’, allowing assets to be sold, creditors to be paid and the whole business to be wound down in an orderly, supervised process. For many businesses, the financial impact of a global pandemic such as COVID-19 will be so severe that liquidation will be the only option to prevent the further escalation of running costs where there is no prospect that a business can trade out debt. Liquidation is an important part of commercial life in South Africa and will have a key role to play where businesses are unable to recover.
However, it is a final, and generally irreversible, solution and it is not necessarily the answer for every business that is going through tough times financially.
Business Rescue
An alternative option can be found in the relatively recent establishment of the business rescue process in Chapter 6 of the new Act. It aims to provide financially distressed companies with breathing room by creating a moratorium on enforcement of creditors’ claims against them, including liquidation applications by creditors, brought after entering into business rescue. It also provides for temporary supervision of the company’s affairs, business, property, and general management by a registered and qualified business rescue practitioner (“BRP”). The ultimate goal of business rescue is:
the development and implementation, if approved, of a plan to rescue the company by restructuring its affairs, business, property, debt and other liabilities, and equity in a manner that maximises the likelihood of the company continuing in existence on a solvent basis or, if it is not possible for the company to so continue in existence, results in a better return for the company’s creditors or shareholders than would result from the immediate liquidation of the company”.6
There are two ways that a company can be placed into business rescue. The first, known as voluntary business rescue proceedings, is by the passing of a board resolution, if the board believes that the company is financially distressed and there appears to be a reasonable prospect of rescuing the company.7 For a company to be ‘financially distressed’ as defined in the new Act, means that “it appears to be reasonably unlikely that the company will be able to pay all of its debts as they become due and payable within the immediately ensuing six months”8 or “it appears to be reasonably likely that the company will become insolvent within the immediately ensuing six months”9. It is worth noting here that the board of directors is specifically prohibited from passing a board resolution to voluntarily begin business rescue proceedings if liquidation proceedings have already been commenced by the company or by a creditor.10
Once the board resolution putting the company into voluntary business rescue has been passed, the company will then have to publish notice of the resolution and a sworn statement of the facts which were relevant to the board’s decision to take the resolution to all affected persons, such as shareholders, creditors, trade unions, and employees, and appoint a BRP.11 If the board of a company has reason to believe that the company is financially distressed but it does not adopt a resolution putting the company into voluntary business rescue, the board is obliged to deliver a notice to all affected persons explaining that the company is in financial distress and explaining why the company has not gone into voluntary business rescue.12 Failure to do so is a breach of the new Act, and a director can be held personally liable in terms of section 218(2) of the new Act for loss or damages that are suffered as a result of this failure. As set out above, a business rescue can be considered successful if it fulfils one of the two main goals in that it either is able to return to trading as a solvent business or it produces better returns for the creditors than an immediate liquidation.
The second method is known as compulsory business rescue proceedings and is done by way of a court order. An affected person can apply for an order commencing business rescue and must satisfy the court that there is a reasonable prospect of successfully rescuing the company and one of three requirements are met – that the company is financially distressed, has failed to make payments with respect to an obligation in terms of a public regulation or contract with respect to employment or labour related matters, or it is otherwise just and equitable for financial reasons that the company should be placed in business rescue.13 Unlike a voluntary business rescue, compulsory business rescue proceedings suspend liquidation proceedings which have already been commenced by the company or by its creditors.14 The liquidation application can then only resume once the application has been adjudicated by the court or business rescue proceedings come to an end.
After his appointment, the BRP will investigate the company’s affairs and make a decision on whether the company can be rescued. If the BRP at any point during business rescue concludes that there is no
reasonable prospect of the company being rescued, he must inform the court, the company and other affected persons and apply to court for the business rescue to be terminated and the company to be liquidated.15 Likewise, if the company is no longer in financial distress, he must notify all of the parties involved and either apply to court for the termination of the business rescue or file a notice of termination of the business rescue proceedings.16
The BRP is also tasked with consulting with creditors, affected persons and the company’s management and to put together a business rescue plan, which must contain a detailed description of the company’s financial situation, his plans or proposals for how the company is to be rescued and the conditions which have to be met for the plan to be considered fully implemented.17 Creditors then have an opportunity to vote on the plan and to decide whether it should be adopted. If a business rescue plan is approved and implemented in terms of the new Act, a creditor is not entitled to enforce a debt owed by the company before the business rescue process commenced, except to the extent provided for in the business rescue plan.19
Business rescue is therefore a valuable tool for businesses that simply need time to implement reform or restructuring that will allow them to keep running in the future or will provide a better return to creditors than an immediate liquidation. It is not hard to imagine that many businesses in a post- pandemic economy will benefit from this kind of arrangement which encourages adaptability and evolution during difficult and trying times.
The need for balance
Both of these processes will be important as businesses start up again after the lockdown. While business rescue is designed to protect a company while an appointed BRP implements reform and works to turn the business around, liquidation is also a necessary process for those businesses that cannot trade out of their financial difficulties. No doubt the courts will be kept busy with many of these kinds of applications in the months ahead and so it is important to make careful and considered decisions and get timeous professional advice on the best option for each case and to try and limit the potential for directors to be held personally liable. This will allow businesses to find the best strategy and avoid unnecessary delays or escalating costs.
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1 Boschpoort Ondernemings (Pty) Ltd v Absa Bank Ltd (936/12) [2013] ZASCA 173 (28 November 2013).
2 Murray and Others NNO v African Global Holdings (Pty) Ltd and Others (306/2019) [2019] ZASCA 152 (22 November 2019).
3 Boschpoort Ondernemings (Pty) Ltd v Absa Bank Ltd (936/12) [2013] ZASCA 173 (28 November 2013), para 16.
4 Murray and Others NNO v African Global Holdings (Pty) Ltd and Others (306/2019) [2019] ZASCA 152 (22 November 2019), para 31.
5 Boschpoort Ondernemings (Pty) Ltd v Absa Bank Ltd (936/12) [2013] ZASCA 173 (28 November 2013), para 22
6 Companies Act 71 of 2008, section 128(1)(b)(iii).
7 Companies Act 71 of 2008, section 129(1)(a) and (b).
8 Companies Act 71 of 2008, section 128(1)(f)(i).
9 Companies Act 71 of 2008, section 128(1)(f)(ii).
10 Companies Act 71 of 2008, section 129 (2)(a).
11 Companies Act 71 of 2008, section 128(3).
12 Companies Act 71 of 2008, section 129(7).
13 Companies Act 71 of 2008, section 131(4).
14 Companies Act 71 of 2008, section 131(6).
15 Companies Act 71 of 2008, section 141(2)(a).
16 Companies Act 71 of 2008, section 141(2)(b)
17 Companies Act 71 of 2008, section 150.
18 Companies Act 71 of 2008, section 154(2).